Intergovernmental Transfers

Anwar Shah, World Bank Forum on Intergovernmental Relations and Improved Service Delivery in Pakistan Bhurban, June 28, 2003

Anwar Shah, OEDCR

Why look at fiscal transfers?

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Important lever in a federal system to ensure achievement of national objectives A tool for bringing a results culture to public sector governance A tool for introducing voice and exit options for citizens through encouraging the adoption of Alternate Service Delivery Framework A tool for creating enabling environment for responsive, responsible and accountable local governance
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Anwar Shah, OEDCR

Fiscal Transfers in Pakistan

What Pakistan has done well: Institutional arrangements for determination of fiscal transfers. ! Where major rethinking is needed: Objectives of fiscal transfers and associated design. Critical for improving public sector performance in the delivery of public services.
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Anwar Shah, OEDCR 3

Institutional Arrangements for Fiscal Transfers

Intergovernmental committees: Canada ! Independent grant commissions: Australia, India and South Africa ! Intergovernmental cum civil society commissions: Pakistan
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Anwar Shah, OEDCR

Design of fiscal transfers

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DESIGN OF FISCAL TRANSFERS MUST BE CONSISTENT WITH OBJECTIVES.

Anwar Shah, OEDCR

Dividing the spoils vs Efficient and equitable service delivery

Dividing the spoils Complex Design
"

" "

Passing the buck transfers: Revenue sharing with multiple factors (Brazil, India, China, Pakistan) Pork barrel transfers ( India and Pakistan) Asking for more trouble grants (deficit grants and bailouts)

Efficient and Equitable Service Provision Simple Design

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Transfers to achieve national minimum standards Equalization transfers with an explicit standard of equalization

Anwar Shah, OEDCR

NFC Awards: Merits

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Excellent institutional arrangements Simple, formula (population only) based transparent and predictable system. Fully harmonized tax system. Fiscal need compensation (partial) Resource royalties returned by origin Special grants to fiscally disadvantaged provinces.
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Anwar Shah, OEDCR

NFC Awards: Demerits

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Manna from heaven weakens government accountability. No discretion on the amount of funds received. Lacks fiscal equity No levers to achieve national objectives No relation to expenditure responsibilities social expenditure needs grow faster than GDP Federal collection of resource royalties hard to justify Special grants ad hoc - unrelated to fiscal capacities

Anwar Shah, OEDCR

PFC Awards: Merits

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Formula based (population, backwardness, tax effort, fiscal austerity, area, development incentive/infrastructure deficiency, hold harmless), transparent Indicators of expenditure needs Better information base about local governments Wage transfers help cover personnel costs
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Anwar Shah, OEDCR

PFC Awards: Drawbacks

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One size fits all large city districts vs smaller rural districts Questionable indicators: tax effort, backwardness Absence of a results culture Fiscal capacities ignored. More revenues with provinces compared with their expenditure responsibilities Weak taxpayer accountability Wage transfers shackle local governments into predetermined public employment creation culture Inappropriate incentives for responsive , responsible and accountable governance
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Anwar Shah, OEDCR

Next Steps
Abandon revenue sharing ! Tax decentralization ! Adopting a program of fiscal transfers
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Fiscal capacity equalization to a standard Transfers to set minimum standards

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Think globally and act locally lessons from international experiences

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Anwar Shah, OEDCR

Objective
Fiscal Gap

Grant Design Better Practices

Reassign (tax decentralization), tax base sharing Fiscal capacity equalization Canada

Practices to Avoid
Deficit grants, tax by tax sharing

Provincial/local fiscal disparities

Australia, Canada, General revenue Germany, Sweden, sharing Denmark, Russia, Poland, Hungary Ex-Indonesian roads and education, Chile S. Africa Canada social assistance Ad hoc grants Conditions on spending

Setting national minimum standard Benefit spillovers Influencing local priorities Stabilization

Block transfers, conditions on service standards Matching grant Open-ended matching

Anwar Shah, World Bank and policy Stabilization 12 Capital with Political upkeep risk guarantee without upkeep

Setting national minimum standards

" Rationale:
" National economic union or internal common market " Redistributive role of the public sector and the national governme nt

" Design: conditional non-matching block transfers with conditions on standards of service and access. No condition on the use of funds. " Better practices: Indonesia roads and primary education grants; Colombia and Chile education transfers; Canada health and post-secondary education transfers. " Practices to avoid: Conditional transfers with conditions on spending; ad hoc grants.
Anwar Shah, World Bank 13

An Example: Education grant to encourage competition and innovation

" Allocation basis to state/local governments: Population aged 5-17 " Distribution basis to providers: Equal per pupil to both public and private schools " Conditions: Universal access to primary and secondary education. Improvements in achievement scores and graduation rates. No conditions on the use of funds " Penalties: Public censure, reduction of grants funds and termination " Incentives: Retention of savings
Anwar Shah, World Bank 14

Indonesia - Specific Purpose Transfers to Local Governments (now defunct) L2. District/Town Road Improvement Grant
" Length

of roads " Condition " Density " Unit cost

L3. Primary School Grant

" School age

children (ages 7-12) " Needs for facilities

Anwar Shah, World Bank 15

Federal financing and health care in Canada

Per capita transfers tied to rate of growth of GDP Conditions: (1) Universality (2) Portability (3) Public insurance but public/private provision (4) Opting in and out (5) No extra billing Penalties: Threat of discontinuation for breach of 1-4. Dollar for dollar reduction for 5. Sunset clause: Parliamentary review every 5 years. Anwar Shah, World Bank

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To reduce provincial/local fiscal disparities

" Design: General non-matching fiscal capacity equalization transfers. " Better practices: Fiscal equalization programs (sources of data: AGC, Finance Canada, Spahn, Lotz) " Paternal: Australia (fiscal capacity plus fiscal needs) and Canada (fiscal capacity only) " Fraternal: Germany (fiscal capacity), Sweden, Denmark " Practices to avoid: General revenue sharing with multiple factors e.g. practices in Brazil, India and Pakistan.

Anwar Shah, World Bank

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A Representative Tax System approach to fiscal capacity equalization Equalization from revenenue source i =
National average tax ratei Per capita base in all statesi = Per capita potential revenue in All states (i)
Anwar Shah, OEDCR

State As own base per capitai

Per capita standardized revenue in state A (i)

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A Representative Expenditure System approach to Fiscal Need Equalization

Equalization entitlement from expenditure category i EQUALS Per capita potential expenditure of State A for category i based upon own need factors if it had national average fiscal capacity MINUS Per capita potential expenditure of State A on expenditure category i if it had national average need factors and national average fiscal capacity

Anwar Shah, OEDCR

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Canada -THE CONSTITUTION ACT, 1982 ______________________________________ 36.(2) Parliament and the Government of Canada are committed to the principle of making equalization; payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of services at reasonably comparable levels of taxation.
Anwar Shah, OEDCR 20

EQUALIZATION PER CAPITA FOR REVENUE SOURCE (i)

=
National average tax ratei Per capita base in 5-provincesi = Per capita potential revenue in 5-provinces
Anwar Shah, OEDCR

Provinces own base per capitai

Per capita standardized revenue in province A

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Graphic Illustration of Equalization, Canada 1994-95

7,000 6,000

Five-Province Standard $4,857

5,180 Equalization Per Capita 3,635 3,854 3,996 4,171 4,325 5,411

6,359

Dollars
5,000

per Capita
4,000 3,000 2,000 1,000 0

3,209

3,451

Fiscal Capacity Pe r Capita (Provincial Ability to Raise Revenues)

Nfld

P.E.I.

N.B.

N.S.

Man

Sask.

Que.

Ont.

B.C.

Alta

Anwar Shah, OEDCR

Note: The above graph illustrates the meaning of the Equalization standard as of 1994-95. This is that, as of that year, any province, together with its local governments, by levying average rates of tax will be able to derive revenues of at least $4,857 per capita (equal to $19,428 for a family of four) with which to finance public services.

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THE AUSTRALIAN PROGRAM

to enable each state to provide without imposing taxes and charges at levels appreciably different from the level of taxes and charges imposed by the other states, government services at standards not appreciably different from the standards of the government services provided by the other states.

Section 13(3) of the States (PIT sharing) Amendment Act, 1978.

Anwar Shah, OEDCR 23

Australia: Secondary Education Expenditure Need Factors - 1995 1996

Table 4 - Government Secondary Education Factors - 1995-96 Disability Factors Dispersion Grade Cost Input Costs Relevant Population Administrative Scale Service Delivery Scale Vandalism & Security Cross-border Category Disability NSW Vic Qld WA SA Tas ACT NT

0.9973 0.9921 1.0093 1.0106 0.9972 0.9952 0.9885 1.0710 1.0014 1.0028 0.9966 0.9950 0.9992 0.9998 1.0016 0.9979 1.0120 0.9950 0.9860 1.0030 0.9910 0.9900 1.0080 1.0340 0.9749 0.8874 1.0983 1.1639 0.9679 1.1422 0.9750 1.2226 0.9946 0.9946 0.9946 1.0065 1.0105 1.0304 1.0463 1.1139 0.9922 0.9906 1.0031 1.0153 1.0166 1.0380 0.9714 1.1141 1.0023 1.0023 0.9973 0.9973 0.9973 0.9923 0.9923 0.9923 0.9965 1.0001 1.0001 1.0001 1.0001 1.0001 1.0660 1.0001 0.9692 0.8658 1.0815 1.1941 0.9772 1.1917 1.0440 1.6605

Anwar Shah, OEDCR

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Figure 3 - Relative Cost of Service Provision Ratios - 1995-96

275 250 225 200 175 150 125 100 75
NSW VIC Qld WA SA Tas ACT NT

274

98

92

99

109

101

109 93

Figure 4 - Relative Revenue Raising Capacity Ratios - 1995-96

125
113 106 104 96 98 92 88 77

100

75

50
NSW VIC Qld WA SA Tas ACT NT

Anwar Shah, OEDCR

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PROCESS
COMMONWEALTH GRANTS COMMISSION
#

FEDERAL CABINET REVIEW

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PREMIERS CONFERENCE
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Germany :: How does the Germany How does the Finanzausgleich work ? Finanzausgleich work ?
A fiscal capacity yardstick is defined per capita (national average with modifications) Each States fiscal capacity per capita is measured against this yardstick Poor States obtain 95 % of fiscal yardstick Rich States pay in progressive steps The Finanzausgleich is a pure horizontal clearing mechanism
The World Bank
Anwar Shah, OEDCR TWURD 27

How does the Finanzausgleich How does the Finanzausgleich work ? (2) work ? (2)
'Marginal levy' on State fiscal capacity in excess of average fiscal capacity
118
State per capita 115 fiscal 112 capacity relative to 109 average 106 per capita fiscal 103 capacity 100

20

40
Marginal rate in percent

60

80

The World Bank

Anwar Shah, OEDCR TWURD 28

Effectiveness of the Finanzausgleich

1999

Anwar Shah, OEDCR

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Sweden: Fiscal Equalization at the Local Level

Central transfer to bring all local governments to national average fiscal capacity ! Special grant for population size, composition and location ! Municipalities above 135 percent of the average contribute to the pool.
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Anwar Shah, OEDCR 30

Denmark: Equalization models and standards

Equalization Counties type Metropolitan Local areas Govts.

Fiscal capacity Fiscal Needs

85% Robin 90% Robin 50% Hood Hood central grant 85% Robin 60% Robin 35% Robin Hood Hood Hood

Anwar Shah, OEDCR

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